Thoughts from Dave Mead and discussion about issues and concerns for Small and Mid-size Businesses. Some discussion topics will include strategic planning and execution, improving profitability and cash flow, maximizing value for exit.

Thursday, October 31, 2013

[Editor's Note: When we initially published this article in 2008, most business leaders were still expecting a "normal" recession and recovery cycle. We now know that we have seen a combination of uncertainty and slow growth. While many companies have reacted relatively passively, some are changing the dynamics. I hope you find this useful. - DPM]

Four Possible Scenarios of the future:

How would your company respond?¹

1. Paralysis/Survival: This describes a situation where external events will be unknown and surprising, and companies will respond to them in a predominantly passive and reactive manner.

This, clearly, is the worst-case scenario. In this situation, "unexpected and disruptive events will increase over the next three years, and companies (and/or economies) will react by pulling into a protective shell." The external shocks could include economic developments such as the nationalization of major global industries (like oil, banking, auto) and significant disruptions to global material flows. On the political front, terrorist attacks could escalate in different parts of the world, and the U.S. led anti-terrorism coalition could fall apart. Isolationism and protectionism may be revived. Companies (could) react by trying to protect existing assets with layoffs, reduced R&D investment, reduced product development, and lower foreign direct investment. Consumers may compound the problem by reducing spending dramatically.

The bottom line in this scenario: A long, global recession

2. Slow Growth:This scenario predicts a future where external events will be known and expected, but companies will respond passively to them.

This, too, is a grim scenario, though not as irredeemably dismal as the previous one. In this case, "disruptive events with moderate impact continue, and while seen as normal, they result in an economic malaise." This scenario would be marked by debt and currency problems in key world economies, though a full-blown long-term global recession is avoided. Unemployment would be higher but manageable, but consumer confidence would be low. Politically, the war against terrorism could head toward a stalemate situation. Companies would get used to the risks of terrorism and learn to cope with their losses. They would make modest investments.

The bottom line in this scenario: Life becomes an overpowering shade of gray

3. Thriving With Chaos: Here, external events will be unknown and surprising, but companies will respond mostly in an active and opportunistic fashion.

In this scenario life is still gray, but sunlight begins to filter through the gloom in some areas. "Unpredictable disruptive external events" would continue, but "corporate and national resolve to be successful in the face of adversity" would drive modest prosperity. While uncertainty would continue, it would be considered a cost of doing business. Companies would try to seize business opportunities amid the disruption and uncertainties, and make increasing investments in areas that seem to be potentially profitable. In the political arena, the continued global realignment of the U.S. with Russia and China would continue to open up new market opportunities, but the Islamic and developing nations would be shut out of these new alliances. The war against terrorism would continue without a clear victory.

The bottom line: Life could be better, but there's money to be made if you know where to look.

4. Global Growth: In this scenario, external events will be known and expected, and companies will respond actively and aggressively.

This, clearly, is the best-case scenario, one in which "countries and peoples of the world recognize common goals and focus on economic development and peace as the route to permanent stability." The key features of this scenario would be that the recession proves short-lived and the business cycle would return to normal; the global coalition against terrorism would evolve into a coalition for peace and commerce, and the threat of terrorism would fade. Investments in new technologies for energy management would reduce the role of oil in Middle Eastern politics. Consumers would feel confident about the future, increase their spending, and lay the foundations of a sustained economic recovery. Trade barriers would be lowered and the developing economies would grow in tandem with the developed ones.

If these four scenarios - or a combination of them - represent what lies ahead in the next three years, what strategies should companies put in place today to deal with them? Clearly, though, neither these scenarios nor the strategies that follow from them will apply across the board. The scenarios will play out differently not only in different industries, but also in various regions of the world. Accordingly, the strategies that companies develop to cope with these situations will need to vary to reflect these differences.

It would be a mistake to allow the uncertainties that prevail today to put business decision making on hold. The future may be unclear, but one thing is certain: In today's circumstances, scenario planning is more than a tool. It is a weapon to combat uncertainty, and the future will belong to companies and executives that wield it well.

How well is your company prepared to respond? Are you taking control of the things that you can? Are your actions strengthening your company - or weakening it? Are you building flexibility into your plans? Have you changed your approach to planning?

The Mead Consulting Group helps dozens of companies and organizations - like yours - every year with scenario planning. The process has helped our clients consistently outperform their competition.

Tuesday, October 22, 2013

[Editor's Note: Recently I have had a number of conversations with business owners and CEOs about sustaining profitability. I thought I would reach into the "article archives." While we first published this in 2003, it is still relevant ten years later in 2013. - DPM]

HOW DO YOU HUNT FOR PROFITS? BY LOOKING IN YOUR OWN BACKYARD

Tier your customers by profitability by creating a profit map. A profit map is a clustering of customers, products, services, and transactions by profitability, and an analysis of the key profit drivers. This forms the basis for rapidly improving a company's profitability through careful management of the details of the business without the need for major capital expenditures.

Let's look at the profit mapping process, using the example of a distribution company. The process has five steps.

Decide to analyze profitability at a "70 percent accuracy" level. Some companies spend a huge amount of time and money setting up an activity-based costing system that is much too detailed. All too often, the measurement becomes the project, and after endless debates, many projects lose momentum before they are translated into actions that hit the bottom line.

The most important results usually will be very clear from rapid, intelligent analysis using best knowledge and rules of thumb. Once a profitability picture emerges, it makes sense to improve the accuracy only where better information will change an important action. In most companies, after the analysis is over, the managers institute only a few high-leverage initiatives.

Construct a profitability database for the company. Select a time period, often two to six months, that is representative, and load the full set, or an excerpted set, of transactions (i.e. order lines) onto a computer. Each transaction should carry crucial information including the identity of the customer and product, as well as special services. Next, develop cost functions and use these to net the transaction's gross margin (GM)

In developing cost functions, it is generally best to allocate costs using an easy-to-measure variable. For example, allocating operations costs by transaction or order line usually works well, as each line entails order-taking and picking. Inventory carrying costs can be handled by rules of thumb, such as holding "A" items for two weeks, "B" items for four weeks, and "C" items for eight weeks. Transportation costs can be allocated through simple decision rules based on customer location (region, near to or far from a distribution center). Where a sales call is needed to take an order, that portion of the selling expense can be allocated by orders. Other costs can be similarly allocated with reasonableaccuracy.

It's important to allocate all costs, including general overhead, for two reasons: (1) this enforces the discipline of viewing the whole cost of the business whendetermining whether to keep or change a major component; and (2) this ties the analysis directly to the company's financial statements, ensuring credibility and accurate projections.This process will yield a database of transactions, each with revenues, GP, and NP. The database can be analyzed to display account, product, and transaction profitability. It will show you where the big pools of profits and losses are. The database also can be used to project the impact of changing the account and product mix, as well as changing the cost of key elements of operations and sales. The former shows the effect of focusing the company on high-profit market segments, while the latter shows the effect of altering the business model to change "bad" customers into "good" customers.

Model a customer - Determine the characteristics of the Chosen Customer. Choose a few customers and products that are reasonably representative, and look carefully at their economics. Try choosing a large and small customer each from a few key market segments, and a fast-moving and slow-moving product from each of a few key product families. Ideally, you will have about six to twelve representative situations to examine closely.

For each customer, look methodically at the profit drivers-revenues, margins, and costs-for different products. Try different business model configurations such as changing the order interval, sales interval, or service interval. Look at the pricing, both price levels and price mechanisms. Altering the product mix and developing substitution programs also can provide valuable levers for profit improvement.

Here, you are looking for "profit levers". Once you have found effective profit levers, check several other similar customers to be sure you can generalize your findings.

Modeling the effects of key profit levers on representative customers works well for three reasons: (1) it will be intuitively clear which elements of the business model (e.g. order pattern) can be changed and what the effect will be; (2) you can actually call the customers to see what their reaction to the potential changes would be; and (3) it will be easier to explain the changes using concrete examples when you "sell" the initiative to your colleagues.

Project to the whole business. Divide the entire business into clusters, or market segments, that are similar to the customers and products you've modeled. See where the big pools of profits and losses are now, and what the profit impact would be of making the changes. This will tell you what's most important to do.

With this picture of current profits and profit improvement potential, you can identify the few high-payoff actions that your company can take relatively quickly. First and foremost, act forcefully to secure the high-profit segment of your business. Only then institute a process to improve the profitability of the marginal part of the business. This process probably will include training front-line sales and operations associates in day-to-day coordination to improve profitability to its highest potential.

What about the unprofitable customers? Here's what the CEO of a major service company said about exiting unprofitable business segments or customers:

"Before exiting, give them a chance to pay higher prices or modify the profit levers. We did exactly that. We knew our profitability was eroding. Through analysis, we found a business segment where we were losing money. Profit analysis allowed us to determine what changes would be required to generate acceptable returns. The underlying issue was not pricing-it was order pattern, order size, and delivery requirements. Before exiting the segment, we told our customers what we needed in order to continue servicing them. To our pleasure, they agreed to make the changes, and we saw a quantum improvement in profitability in six months!"

Finally, phase out the parts of the business that cannot be made profitable. This will be counter-intuitive and some in the company will resist, but keep your eye on the huge upside to refocusing 20-40 percent of your sales force and operations assets away from tending unprofitable business and toward aggressively growing your share of the highest-profit end of the business.

Institutionalize profit mapping.Reflect on the value produced by determining the tiers of customer profitability ("profit mapping") and decide to institutionalize the process.Repeat the analysis every three to six months.Once you have set up the analysis, subsequent rounds will go very quickly. The process itself will build teamwork and it will become a new way of looking at the business. In parallel, build profit mapping into the new account qualification process. As your profitability improves, new opportunities will constantly be created. The better you get, the better you can get.

From financial information to action

A service company CEO mentioned above reflected on his experience with profit mapping, "Financial systems often do not have the information that you need. If they did, the problems would have been solved long ago. To be truly effective, you need to create a cross-functional team that understands how the business operates. This will allow the conversion of financial information into management information which, through analysis, will lead to action."

By the way, how do you hunt for profits? By looking in your own backyard-again and again and again! In work with Mead Consulting clients, our clients use proven methods designed to center their business around delivering continuous value to the best customers. Revenue and profit growth can be realized in the first 90 days of implementation.

Welcome to Mead's Issues for Growth

Since 1991, we have been publishing a periodic eLetter "Issues for Growth" that contains articles or thoughts of interest to business owners looking to grow and improve their businesses. We invite your comments and discussion.

About Me

We have been consulting with small and mid-size businesses for over 30 years, helping companies move to the "next level of success" by focusing on strategies that the company can execute well and aligning all activities within the company to those key strategies.
I have started and run 7 companies - a couple of great successes, a few moderate successes, a couple of screaming failures.